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every major headline grabbing restructuring over the past
several years.

On January 17, 2017, the Court of Appeals for the Second Circuit
issued its long-anticipated opinion in Marblegate Asset
Management, LLC v. Education Management Finance
Corp.,[1] ruling that Section
316(b) of the Trust Indenture Act of 1939, 15 U.S.C.
§ 77ppp(b) (the "Act"), prohibits only non-consensual
amendments to core payment terms of bond indentures. The 2-1
ruling vacated and remanded the decision of the district court
determining that the defendants (two affiliated note issuers and
their corporate parent) violated Section 316(b) by engaging in a
series of transactions that, while they did not amend the governing
indentures, were designed to restructure the defendants' debt in a
manner that deprived non-consenting noteholders, including the
plaintiffs, of their practical ability to collect payment on the
notes. The Second Circuit opinion clarifies an issue that had
caused substantial doubt and debate in the debt markets and
provides debt issuers with broader ability under the Act to
restructure debt outside of bankruptcy court.

Section 316(b) of the Act provides in relevant part that "the
right of any holder of any indenture security to receive payment of
the principal of and interest on such indenture security, on or
after the respective due dates expressed in such indenture security
. . . shall not be impaired or affected without the
consent of such holder . . . ." Prior to
the district court ruling in Marblegate, most courts had
construed Section 316(b) narrowly, holding that it protects
non-consenting bondholders only from changes to core payment terms
that affect their legal rights to principal and interest or their
standing to sue for collection, and not to transactions that might
reduce only their practical ability to obtain repayment.

In Marblegate, however, the district court interpreted
Section 316(b) more broadly, holding that in some circumstances it
protects the "ability" of Noteholders to receive payment, and that,
even where a transaction does not modify the payment terms of an
indenture, the Act is violated whenever a transaction "effect[s] an
involuntary restructuring." The plaintiffs in
Marblegate challenged a planned restructuring of debt of
EDMC, a for-profit higher education company, and two of its
subsidiaries. The plaintiffs held notes issued by the
subsidiaries and guaranteed by the parent. Pursuant to the
restructuring, (i) substantially all assets of the subsidiary
issuers would be transferred to a new EDMC subsidiary following a
consensual foreclosure on the assets by their secured creditors;
(ii) EDMC's guarantee of the notes previously issued by the two
subsidiaries would be released; and (iii) the new subsidiary
would issue debt and equity to consenting creditors and continue
the business. Thus, although the indentures governing the
existing notes were not amended, the result of the transaction was
to transform the issuers into "empty shell[s]" and deprive
non-consenting noteholders of EDMC's parent guarantee.

Plaintiffs, the only holdout creditors, sued to enjoin the
transaction on the ground that it violated Section 316(b) of the
Act. The district court declined to grant a preliminary
injunction, but concluded that the plaintiffs were likely to
succeed on the merits of their TIA claim, reasoning that the Act
prohibits any non-consensual debt restructuring effected outside of
bankruptcy court. Following a bench trial, the district court
enjoined EDMC from releasing the parent guarantee on the notes held
by plaintiff. Acknowledging the "potentially troubling"
implications of its holding in "rewarding holdouts" and the Act's
"arguable obsolescence given the expense and complexity of modern
bankruptcy," the district court nevertheless concluded that its
holding was compelled by the language, structure, and legislative
history of the Act.

The Second Circuit vacated and remanded, agreeing with EDMC's
argument that, because the transaction did not formally amend the
payment terms of the indenture governing the notes, it did not
violate the Act. The Court concluded that the statutory
language was ambiguous and failed to resolve the issue before it,
but that the Act's legislative history "convinces us
. . . that Congress sought to prohibit formal
modifications to indentures without the consent of all bondholders,
but did not intend to go further by banning other well-known forms
of reorganization like foreclosures." The Court further
reasoned that the district court's ruling undermined the interest
in uniform interpretation of indentures because it made the
subjective intent of the issuer relevant to the statutory analysis.
The Court concluded that, because the transactions did not
amend the "core payment terms" of the governing indentures, the
plaintiff could not invoke Section 316(b) to retain an "'absolute
and unconditional' right to payment of its notes." Judge Straub,
dissenting, argued that the plain language of the Act prohibited
defendants "from engaging in an out-of-court restructuring that is
collusively engineered to ensure that certain minority bondholders
receive no payment on their notes, despite the fact that the terms
of the indenture governing those notes remain unchanged."

The Second Circuit's ruling resolves uncertainty in the bond
market engendered by the district court opinion and other cases
following it, and enhances the ability of bond issuers to
restructure debt outside of bankruptcy court without unanimous
bondholder consent. Commentators have criticized the district
court rulings on the grounds that they departed from practitioners'
understanding of the Act, gave holdout noteholders leverage to
block out-of-court restructurings, and made it more likely that
issuers would file for bankruptcy protection. The Second
Circuit's ruling establishes a clear rule that provides issuers
with additional options to restructure debt through negotiations
with creditors without resorting to the bankruptcy courts.

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